How to Invest in Emerging Markets

What are the risks facing emerging markets this year? And will investors who venture in be rewarded? We reveal the funds to add to your portfolio

After a strong 2017, emerging markets are on course for further gains in the coming 12 months and beyond, but, as ever, it’s going to be a bumpy ride, warn analysts.

The MSCI Emerging Markets index returned 37.28% in 2017 – its best performance since 2009 – to add to its 11.19% gain in 2016.

This performance was driven by improving global and regional economies, resilient industrial data in China, continued earnings upgrades for Asian equities and a weak US dollar, says Min Feng, senior investment specialist at Nomura.

But emerging market equities still appear cheap relative to history and other regions. That’s because they are currently recovering from a low base. The commodity price slump between 2013 and 2015 meant the index saw negative returns three years running.

Now, Russ Mould, investment director at AJ Bell, notes that emerging markets overall are trading at around 1.7 times on a price/book basis, compared with cyclical peaks north of three times.

Still, investing in emerging markets is not for the faint hearted and should only be done with a long-term time frame in mind.

20 Elections in 2018

“Although the current situation is about as calm as emerging markets get, a shock from the developed world would be felt in emerging markets as well,” says Hermes’ Gary Greenberg.

As ever, politics will also weigh on emerging markets. There are elections in 20 different countries including Russia, Mexico and Brazil. While the result in Russia shouldn’t spring any surprises, Paul Greer, senior trading for emerging market debt at Fidelity, expects “heightened uncertainty and asset price volatility”.

Then there’s China, where a hard landing is still possible, though most economists do not expect this to happen.

China Tech Firms Still Attractive

Most are still positive on the region. Jan Dehn, head of research at Ashmore, isn’t worried about increased volatility going into elections. He says any extreme mispricing of assets will offer opportunities for investors to outperform the markets.

Tom Wilson, head of emerging market equities at Schroders, forecasts an aggregate growth rate of 4.9% in 2018 – in line with 2017.

A rebalancing in the make-up of the largest companies in the emerging market universe, from commodity-based firms to technology giants, should help with gains.

While no fund in the Investment Association Global Emerging Markets sector currently holds a Gold Morningstar Analyst Rating, there are five rated Silver, three of which have four-star performance ratings.

One of these, Aberdeen Emerging Markets, had a “test of character” in 2017, according to Morningstar analyst Mark Laidlaw. It underperformed the MSCI Emerging Markets index by a fifth. This was because the fund is underweight tech names due to the team’s view on valuations and quality. It only added a position in Tencent (00700) in the third quarter of 2017.

Laidlaw still thinks there’s “plenty to like” about the fund, managed by Devan Kaloo, who focuses on quality firms trading at attractive prices. “Over the long term, it has done a strong job for investors.”